Transit financing trapped in a house of cards

The best laid schemes o’ Mice an’ Men, gang aft agley— an old refrain among transit administrators caught in the backlash of an economy run amok. Little did they know their creative financing five years back would eventually become ensnared in the current mortgage-lending debacle.

Homeowners wanted more house than they could afford. Bankers wanted higher returns than they could get from conventional securities. Wall Street executives slipped out the back with a boatload of bonuses.

As the ramifications of their actions further metastasize, the plan has definitely gone awry for no less than 31 transit agencies now staring down demands from bankers for well over $2 billion in immediate termination payments.

Before even thinking of the predicament transit agencies face, trying to make sense of the opportunistic misdealing that led to the collapse of the nation’s financial conglomerates and subsequent federal bailouts strains my liberal arts background.

Financing breakdown

The problem the transit systems presently face stems from the recent breakdown in longstanding financing agreements with their banks. As part of the once common practices known as LILOs (lease-in/lease-out) and SILOs (sale-in/lease-out), many transit authorities sold buses, rail cars and other equipment capital property to banks, then leased the capital property back at a discounted rate. The agencies received a large sum of money up front, which went toward upgrades in the facilities and equipment. Meanwhile the banks were able to rely on frequent lease payments and write off taxes on the depreciating property.

One important stipulation was major insurance companies guarantee all LILO and SILO arrangements in the event either side could not uphold its end of the agreement. Enter American Insurance Group (AIG). Another stipulation held the insurer to an excellent credit rating. Exit AIG. The giant corporation nearly went bankrupt in September, tarnishing its credit and leaving the best-laid schemes teetering on technical default.

Whether the transit agencies should have entered into these tax shelters in the first place is moot at this point. In fact, transit officials say from 1988 to 2003 the federal government promoted such bank deals in its innovative financing handbook for further infrastructure investments. Dozens of transit authorities entered into nearly 90 of these arrangements worth more than $16 billion.

The IRS put a stop to such leasing arrangements in 2004, and pressured banks to stop the practice of tax shelters, giving them until the end of 2008 to square their accounts. Before that happened, some banks have threatened to take action to collect as much money as possible from the cash-strapped transit agencies.

Head to the Hill

In November the top executives of 11 transit agencies across the U.S. went to the Hill to stand in line and plead with Congress for help with the backlash of deals gone bad. Transit agencies that include New York, Houston, Los Angeles, St. Louis, Atlanta and Chicago want the government to step in as guarantor to prevent the predatory actions of the lending banks. Transit officials maintain such an intervention would not cost the government because they will continue business as usual to make the established lease payments on time.

Washington, D.C. Metro says it has reached a settlement with the KBC Bank of Belgium, which demanded $43 million in termination payments after its leveraged transaction unraveled under the AIG collapse. Metro says it could owe $400 million in payments from 14 other tax-shelter arrangements.

The agency meanwhile has continued to pay AIG even though KBC no longer recognizes the company as a legitimate guarantor. An AIG spokesman explained that the company has an obligation to provide security and still stands on that promise.

If this gloomy scenario plays out in full, such gargantuan and unbudgeted payouts could cripple these transit authorities just at the time public transportation is basking in increased ridership and environmental stewardship.

If the government does not intervene, agencies are considering cutting transit services and repairs. The agencies in question could be looking at hefty fare increases, deferred maintenance and a halt to new construction projects.

Though Metro has not disclosed the details, the fact the two sides have been able to negotiate a settlement suggests the potential for less adverse solutions. As yet, the federal government has not made its decision to intervene on behalf of the transit industry. BUSRide will continue to monitor the progress.

Posted by DaveH
on Jan 1 2009. Filed under Finance, Transit.
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